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Returns on absolute return funds are being eaten up by charges, according to one wealth manager.

According to Alan Miller, founding partner at SCM Private, a large proportion of gains are eroded by total expense ratios (TERs).

“SCM analysis of the performance of the 28 UK Absolute Return Funds which have three-year performance data shows that on average, 39% of the underlying gains were eaten up by the reported charges,” he says.

Miller said unless a manager can achieve high pre-fees performance, an investor would probably benefit more financially by putting half of their money in a one year building society account and the remainder in a UK equity tracker.

“One can currently obtain 3% plus in a one-year fix from a number of financial institutions, so even if markets fell by 15%, say, over the next year, the loss would be just 6.2% allowing for a typical tracker costing 0.3% pa, and if the market rose by 15%, the overall gain would be 8.7%,” he said.

Miller said this would be less risky as “the investor would not be at the mercy of the individual fund manager strategies”.

Absolute return funds have faced criticism recently for their name being misleading, resulting in the IMA reviewing the sector categorisation.

However, Tom Becket, manager of the Psigma manager portfolio service, said not all had lived up to a bad reputation, adding some have met their remit of positive and uncorrelated returns produced with low volatility.

“Generating these returns in a highly correlated world, punctuated by extreme bouts of extreme panic and uncontrolled euphoria, has been extremely challenging,”he said. “In fairness to those who have underperformed the high expectations, it is hard to imagine a less supportive environment to achieve their aims.”

Becket said he is happy to hold absolute return funds for his clients where he has high conviction in the managers. He named the Henderson Credit Alpha fund and the Legg Mason Global Credit Absolute Return fund as prime choices.